Tentative agreement reached on State Water Project contract renewals

Metropolitan Water District SealThe Department of Water Resources and the State Water Contractors have reached a draft tentative agreement on a package of amendments to the State Water Project contracts that will extend the contracts to 2085, among other provisions.  At the April 8 meeting of the Metropolitan Water District’s Water Planning and Stewardship Committee, Water Resources Management Manager Devan Upadhyay updated the Committee members on the tentative agreements that have been reached after nearly 10 months of negotiations.

Back in May of 2013, Metropolitan Water District and the other 28 state water contractors began discussions with the Department of Water Resources to extend the contract terms beyond 2035, which is the date when most of the contracts will end.  Negotiations were focused only on the financial provisions of the contract, such as billing procedures and DWR’s operating reserves, he noted.

Mr. Upadhyay then gave a brief background on the negotiations.  “The first policy that DWR has had is that they will not issue bonds to fund their capital program beyond the end of the contract term, which right now is 2035,” he said.  “This creates a financing compression issue where our capital costs and the payments we have to make to DWR are higher than they would be if they used full 30-year debt. … the longest period of debt that they are issuing right now is 21 years, which is not as long as you would typically use debt for to fund a capital program for the facilities that they have.”

The second key policy that they have is even though this is just a discussion of the financial terms in the contract, they want to go forward in an abundance of caution and have a full CEQA rule and environmental impact report for any amendment that would extend the contract,” he said.  “Before they can go forward with that CEQA review and the EIR, they need to understand what the terms are that have been negotiated.”  The CEQA process will start this summer, and in potentially a year from now, they would be coming back to the Board for approval of the full amendment, he said.

There have also been challenges with DWR in the way they manage SWP finances, he said.  The current billing methods are contractually defined that requires DWR to recover the costs for O&M that does not match the repayment for those charges.  “They have very unconventional charges and an unconventional approach,” he said.  “They finance their O&M costs over a long period of time which is unusual, and they also issue surcharge each year to make up for being able to cover their capital costs in a given year.  So they don’t issue a normal flat bill that covers their capital costs.  Instead, they issue a bill and then they have to go through a series of surcharges that would cover their capital costs, so it’s very complex.”

There has also been a history of disagreements, Mr. Upadhyay said.  “One of those big disagreements we’ve talked to you about is related to the Davis-Dolwig costs,” he said.  “They are not supposed to bill us for recreation or fish and wildlife enhancement costs, and yet we continually find those in our bills, and have to go through a process of reviewing and protesting them.”

Edmonston Pumping Plant Photo by Maven Click here to take a photo tour of the Edmonston Pumping Plant.
Edmonston Pumping Plant photo by Maven
Click here to take a photo tour of the Edmonston Pumping Plant.

DWR’s current operating reserves for the State Water Project are about $30 million, which Mr. Upadhyay characterized as pretty limited for a utility of its size.  “However, their billing approach, with the way they bill us, with overbillings and then credits that we get back – that billing approach acts like a reserve; it gives them cash flow that allows them to manage within the year.”  He also noted that in the past when DWR had cash flow issues, such as during the power crisis in the early 2000s, the contractors have stepped in because they have an interest in making sure the SWP is full funded.

These issues are largely dealt with in the new terms,” he said.  “The first key thing is a 50-year extension.  Right now, the term ends in 2035, this would extend it 50 years to end in 2085, which then allows DWR to use this longer term debt financing period 30 years or more as they see fit to be able to finance their capital program,” he said, noting that this will reduce the payments Metropolitan and other contractors will have to make, resulting in significant savings.  “We’re talking about between now and 2035, in some years, $50 million of more dollars to Metropolitan, and in some cases, much more than that as a result of relieving this financial compression,” he said.

There is an agreement to move to a simpler billing method, Mr. Upadhyay said.  The transition will take time, so all of the costs incurred before 2035 will be dealt with under the old financing, but everything else incurred after that date will be on the simpler approach, he said.  “The way I would characterize that is they are going to issue bills to the contractors that match their O&M needs in that year and their debt service in that year, which is similar to what you see at Metropolitan,” he said.  “We are putting together rates and charges that are matching our projected costs for that year, which is not the way they issue the bills.”

The amendment eliminates the surcharges as well as the financing of DWR’s O&M costs, which means that their cash flow is going to be reduced, due to no longer having overbillings that are credited back, he explained.  While this will make the bills easier to understand, it’s also going to reduce DWR’s operating reserves, and so one of the terms is to increase the reserve from $30 million to $150 million.  “That is equivalent to about 90 days of operating expenditures, which is pretty reasonable for a utility of that size,” he said.  “So we are going to simplify the bills, but then give them an equivalent operating reserve that they’ll be able to work off of. The key here is that they are going to build up that reserve, but not by increasing charges to us.  They are not going to bill us to build up that reserve with the cash flow that they already have over time. … We’re going to get the benefit of these reductions in charges, and they are going to have to increase their reserves over time as they get cash flow coming in as opposed to just increasing our bills to generate another $120 million to get to that $150 million.”

The agreement calls for the creation of a reinvestment account, something the contractors have wanted for some time, Mr. Upadhyay said.  “The state came in and provided funding for the SWP when they had a cash crunch a few decades ago, and the way they did that is they provided some loans and some grants that would be used for the SWP,” he explained.  “The contractors are paying those back through our bills all the way through 2035 with interest, and as those payments are going back to DWR, they are able to use those for other state water resource development system purposes.  What will now happen is an account will be established to capture those funds as they are paid back and we will be able to track how those dollars are used to be reinvested in the SWP.  This is basically a line of sight to the use of that fund and those dollars that we haven’t had before, which is very important for us.”

California Aqueduct Mar 2013 #6 smaller
California Aqueduct, picture by Maven

The agreement will also establish an SWRDS Finance Committee that will have members from both the contractors and DWR, he said.  The Committee will have five members from DWR and five members from the contractors, of which Metropolitan, as the largest contractor on the SWP, will have a permanent seat.  The Committee will formally allow the contractors to weigh in on financial policy matters directly with staff, he said.

This also sets a pretty clear line with respect to what we’ve referred to as Davis-Dolwig issues,” said Mr. Upadhyay.  “As a result of this negotiation, there is a clear billing prohibition in the contract that DWR is prohibited from charging contractors for recreation or fish and wildlife enhancement costs.  It also clarifies that the prohibition includes both capital costs and O&M costs.  There have been positions in the past that perhaps those O&M costs are a gray area, but this clearly identifies that they are prohibited from billing us for both of those aspects of recreation and fish and wildlife costs.”

There are some other key financial provisions such as establishing a Chief Financial Manager position at DWR to be a single point of authority over the finances, requiring DWR to give advance notice of any extraordinary billing items they might have, and putting limitations on when they are able to issue supplemental bills, he said.  There are also a series of financial reporting principles that they’ve agreed to, but it’s going to take a few years before they can issue reports consistent with those principles, he said.

And finally, the rate management credits that are currently are capped at $40.5 million per year, of which Metropolitan gets about half,  those credits will now go up to $48 million,” Mr. Upadhyay said.  “Through 2035, we would be seeing those credits coming back as they make this transition in their billing system.”

I don’t want to confuse the issue,” Mr. Upadhyay clarified.  “The billing system will be implemented in the next few years.  Those changes, we’ll see those benefits but recall that some of the costs will continue to be amortized out to 2035, which is why those rate management credits continue to be in place through that time period.”

Those are very generally the key items that are part of the Agreements in Principle, but the formal agreements haven’t actually been drafted yet, so what I’m sharing is very general, he said.  “DWR’s target and the contractor’s target is to get that done by July 1st.  DWR is then going to go through an environmental review process for the contract amendment – that could take a year, which would carry us through to the middle of 2015; it really depends on how quickly that’s done.  …  DWR has to take that contract amendment before the Legislature and review.  The legislature doesn’t have to approve it, but there would be a review in Committee there, and then we would be bringing that amendment to your Board for consideration in the 2015 time frame, after they’ve gone through that process.”

Regarding the Bay Delta Conservation Plan, there was an objective put on the table by two contractors, Butte and Plumas County, he said.  “Their objective was quite clearly to opt out of the costs associated with BDCP’s conveyance facility.  That objective was not addressed in these negotiations.  In fact it will be included as part of the separate negations process for the BDCP cost allocation, but it is recognized that it will be included in the separate BDCP cost allocation discussions and negotiations.”

Director Steiner asked if the BDCP was anywhere in the contract … where does it fit in here?

This agreement would extend the contract, and then DWR would be able to use the contractual provisions to seek reimbursement for capital expenditures,” responded Devan Upadhyay.  “There is no allocation or anything like that associated with BDCP; it’d just be another facility they’d be pursuing and they’d be recovering those costs through the contract.”

“So it would be just a regular billing once the process gets underway,” said Director Steiner.

That’s right,” replied Mr. Upadhyay.

I would add to that that this is needed, with or without BDCP,” added General Manager Jeff Kightlinger.  “This is not a condition, but you could not do BDCP without some sort of extension, so you do need to do this if you’re ever going to do a BDCP, but you also need to do it regardless.”

Public Participation

As part of the Monterey Agreement settlement, the public was allowed to sit in on the negotiating sessions as well as comment.  The Planning and Conservation League, C-WIN, and other environmental, fishing and stakeholder groups followed the negotiations.  They provide their latest comments here:  March 4th PCL et al SWP Water Supply Contract Extension Comment (2)

For more information …

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